Zoom Telephonics: Strong Management And Strategy Create Growth Potential

Summary

• Zoom Telephonics sells modems and other devices under the Motorola brand.
• It's currently break-even, at best, but a number of catalysts could trigger meaningful profits by 2022 causing the shares to rally.
• Near-term catalysts may include: relocating production to reduce tariffs, a Nasdaq listing, growing product categories, increased B2B sales, and international expansion.
• Their strategy makes sense and could create a runway for gaining market share given the company's small size today.
• Management is strong, aligned with shareholders and potentially overqualified for a company of this size, suggesting big goals for the business.

Zoom Telephonics (ZMTP) is a small-cap growth opportunity that has demonstrated growth in excess of 20% over recent years. It will likely hit profitability in the next 12 months. Product quality is high, management is strong and well-aligned with shareholders. Zoom's plan to expand into B2B sales in addition to its current consumer channel may provide a further leg to growth. A Nasdaq listing could provide a further catalyst.

Overview

Zoom Telephonics makes cable modems and other networking equipment sold under the Motorola brand primarily. These products are sold to consumers through Walmart, Best Buy, Amazon, Target and others. It should not be confused with the video-conferencing company which is entirely separate.

Top line growth has been strong historically, though profitability continues to lag.

Source: Company Q1 presentation

Impressive Products

The company's products are well-regarded. They sell modems primarily under the Motorola brand, and generally appear to receive 4.5-star reviews or better on Amazon. Wirecutter ranked their cable modem the best in December 2019.

Growth Strategy

The company's strategy now calls for it to add a B2B element to its B2C business. It has well-reviewed products that consumers appreciate. It makes sense for them to offer these products to cable companies to provide to their users. It's another sales channel for the business, and they have a clear story with a quality product potentially requiring less customer support to maintain. The company doesn't sell into this market at any scale today, so it's largely upside.

Product expansion into cellular modems and digital home scenarios (IP cameras, home sensors, etc.) offers further upside, as does the prospect of medium-term international expansion. Given its size, this company has a large growth runway if it can continue to execute.

Management

Executive chairman Jeremy Hitchcock owns 20% of the shares, recently buying more in a private placement last month. He previously sold his company, Dyn, to Oracle. Jonathan Seeling, co-founder of Akamai is also on the board. These are seasoned technology executives buying shares in material amounts. It's unlikely we'd see this caliber of involvement with a $50M market cap company unless they saw potential.

The company is currently searching for a new CEO.

Catalysts

There are various positive catalysts for Zoom on the horizon:

• Tariff removal - the company has been hit by China tariffs, cutting gross margins from 37% to 25% and delaying a move to profitability. Management expects relocation of manufacturing to Vietnam, as they stated in their February 2020 release on Q1 earnings: "Moving our production to Vietnam will not only benefit us with a lower overall tariff exposure, but it will also further strengthen and diversify our global supply chain model."
• B2B Sales Selling through B2B channels, targeting second-tier cable companies who don't have in-house modem production should yield incremental volumes and it's reasonable to think these efforts may succeed given product quality.
• Nasdaq Listing - The company's press release of late May included this statement "The Company’s Board will also analyze and explore the costs and benefits of a Nasdaq listing as it relates to increased investor awareness, liquidity, and other factors." Again, the company clearly has aspirations beyond its current size.

Projections

The company is currently losing money. However, that may be expected to change in the coming years. Here's how that could play out.

($ millions)	2019 Actual	2020 est.	2022 est.
Revenue	$38M	$47	$69M
Gross Profit	$11M	$16M	$24M
Operating Costs	$14M	$15M	$17M
Pre-Tax Profit	-$3M	$1M	$7M

Click to enlarge

The above estimates assumes they are able to normalize gross margin back to 35% after relocating production to Vietnam and that they are able to capture some scale advantage in operating costs as they grow. The key point here is that the company may be close to positive profits.

Risks

• Even though the company seems close to profitability, it is loss-making today. It may require further funding in future if profitability isn't achieved in the near term.
• The company uses Motorola's brand, this agreement has been extended to 2025, but Motorola may capture some of the upside if the company is successful in contract renegotiation in the medium term.
• Though the product has had success with cable modems, new products are unproven and may not achieve traction.
• The company is currently without a CEO.
• There is some execution risk in relocating production to Vietnam and risk of supply chain disruption due to COVID-19. Though management has suggested both risks are largely behind it.

Valuation

It appears reasonable that Zoom will continue to grow at 20% or more for the foreseeable future based on the market opportunity supported by product quality and historical trends. As such a 15x-20x valuation appears warranted if not conservative. Assuming $7M of pre-tax profit in 2 years taxed at 20% and discounted back to today at 10% discount rate, that's $4.60 of profits in today's dollars and on a 15x multiple that suggests a $3.30 share price with 21M shares outstanding.

This is a growth company that is currently unprofitable, but there appears to be the potential for upside for the patient investor. A Nasdaq listing may provide a further catalyst in the interim.

Analyst’s Disclosure: I am/we are long ZMPT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Not intended as investment advice. Author does not undertaken to update this report or guarantee its accuracy. Author's holdings may change without notice. Please seek professional advice before making any investment decision. Investing involves risk of loss of capital.

Comments

[Clark158f1]

Took profits at $ 9 and went short at the same price.

[Senna2002]

@Clark158f1 What is the news for today to justify this gain?

[Clark158f1]

@Senna2002

No news...someone decided to run it

[User 287090]

Dilution, dilution, dilution

[DF Ventures]

At current share price of $3-4, are you still bullish on this company? New CEO and BoD seems to have given this company a facelift. However, they operate in a very competitive landscape, not sure if their products do actually have an edge over much larger competitors like Netgear

[Alta500]

New ticker effective 12/8/20: Change from ZMTP to MINM

[Rational Expectations]

Also, a further update reflecting an exchange with investor relations post-publication. The company is currently very focused on retail rather than B2B. The prior CEO (Wytanis) arguably had some B2B objectives, and those could theoretically return in future, but for now the company very retail focused.

[Double Eagle]

A couple of questions for you...….

(1) Why target a 20% tax rate in the near term when the company has in excess of $40M in carryforwards?
(2) Why have such a conservative looking revenue est. for 2020 of $47M when the company's rate of growth in Q1 is substantially above what you appear to have in mind for the entire year, and it'll only take an additional $5M+/- in sales growth over the last three quarters of the year to reach your estimate?

While interested parties are aware that ZMTP chose to forego a webcast at the time of Q1's earnings announcement, they might be interested to learn that mgt. will review the company's outlook, etc. after the business portion of the annual meeting, which is scheduled for 7/17 @ 10:00 a.m. The link is virtualshareholdermeeting.com/ZMTP2020.

[Rational Expectations]

@Double Eagle

(1) good point on tax-loss carryforwards, the firm's IR also made a similar point offline, here's the detail on that for those interested. Agree that's a source of further upside (from 10Q):
“As of December 31, 2019 we had federal net operating loss carry forwards of approximately $56.3 million which are available to offset future taxable income. They are due to expire in varying amounts from 2020 to 2038. As of December 31, 2019, we had state net operating loss carry forwards of approximately $11.4 million which are available to offset future taxable income. They are due to expire in varying amounts from 2031 through 2038. A valuation allowance has been established for the full amount of deferred income tax assets as management has concluded that it is more-likely than-not that the benefits from such assets will not be realized.

(2) Yes, the company could well over-deliver beyond that estimate in 2020 and indeed beyond. My main goal is to show that they are likely to get to profit this year, I didn't want to stretch the numbers too much to get there especially in a year like 2020.

Taking a step back, my goal is to show the company is cheap today, even on conservative assumptions. There appears to be a margin of safety here.

[Ray Bonneau]

I had been watching this company for awhile, and I finally made an investment into the company based on the Q1 report. The re-signing with Motorola to extend the licensing agreement through 2025 plus the move to Vietnam made this a good opportunity.